Managers-Net

Pareto Analysis (the 80:20 rule)

The Pareto effect.

In practically every industrial country a small proportion of all the factories
employ a disproportionate number of factory operatives. In some countries
15 percent of the firms employ 70 percent of the people. This same state
of affairs is repeated time after time. In retailing for example, one usually
finds that up to 80 percent of the turnover is accounted for by 20 percent
of the lines.

This effect, known as the 80 : 20 rule, can be observed in action so often
that it seems to be almost a universal truth. As several economists have
pointed out, at the turn of the century the bulk of the country’s wealth
was in the hands of a small number of people.

This fact gave rise to the Pareto effect or Pareto’s law: a small proportion
of causes produce a large proportion of results. Thus frequently a vital
few causes may need special attention wile the trivial many may warrant very
little. It is this phrase that is most commonly used in talking about the
Pareto effect – ‘the vital few and the trivial many’. A vital few customers
may account for a very large percentage of total sales. A vital few taxes
produce the bulk of total revenue. A vital few improvements can produce the
bulk of the results.

The Pareto effect is named after Vilfredo Pareto, an economist and sociologist
who lived from 1848 to 1923. Originally trained as an engineer he was a one
time managing director of a group of coalmines. Later he took the chair of
economics at Lausanne University, ultimately becoming a recluse. Mussolini
made him a senator in 1922 but by his death in 1923 he was already at odds
with the regime. Pareto was an elitist believing that the concept of the
vital few and the trivial many extended to human beings.

Much of his writing is now out of favour and some people would like to re-name
the effect after Mosca, or even Lorenz. However it is too late now
– the Pareto principle has earned its place in the manager’s kit of
productivity improvement tools.

This method stems in the first place from Pareto’s suggestion of a curve
of the distribution of wealth in a book of 1896. Whatever the source, the
phrase of ‘the vital few and the trivial many’ deserves a place in every
manager’s thinking. It is itself one of the most vital concepts in modern
management. The results of thinking along Pareto lines are immense.

For example, we may have a large number of customer complaints, a lot of
shop floor accidents, a high percentage of rejects, and a sudden increase
in costs etc. The first stage is to carry out a Pareto analysis. This is
nothing more than a list of causes in descending order of their frequency
or occurrence. This list automatically reveals the vital few at the top of
the list, gradually tailing off into the trivial many at the bottom of the
list. Management’s task is now clear and unavoidable: effort must be expended
on those vital few at the head of the list first. This is because nothing
of importance can take place unless it affects the vital few. Thus management’s
attention is unavoidably focussed where it will do most good.

Another example is stock control. You frequently find an elaborate procedure
for stock control with considerable paperwork flow. This is usually because
the systems and procedures are geared to the most costly or fast-moving items.
As a result trivial parts may cost a firm more in paperwork than they cost
to purchase or to produce. An answer is to split the stock into three types,
usually called A, B and C. Grade A items are the top 10 percent or so in
money terms while grade C are the bottom 50-75 percent. Grade B are the items
in between. It is often well worthwhile treating these three types of stock
in a different way leading to considerable savings in money tied up in stock.

Production control can use the same principle by identifying these vital
few processes, which control the manufacture, and then building the planning
around these key processes. In quality control concentrating in particular
on the most troublesome causes follows the principle. In management control,
the principle is used by top management looking continually at certain key
figures.

Thus it is clear that the Pareto concept – ‘the vital few and the trivial
many’ – is of utmost importance to management.

The Pareto chart

A Pareto chart is a graphical representation that displays data in order
of priority. It can be a powerful tool for identifying the relative importance
of causes, most of which arise from only a few of the processes, hence the
80:20 rule. Pareto Analysis is used to focus problem solving activities,
so that areas creating most of the issues and difficulties are addressed
first.

Some problems

Difficulties associated with Pareto Analysis:

Misrepresentation of the data.

Inappropriate measurements depicted.

Lack of understanding of how it should be applied to particular problems.

Knowing when and how to use Pareto Analysis.

Inaccurate plotting of cumulative percent data.

Overcoming the difficulties

Define the purpose of using the tool.

Identify the most appropriate measurement parameters.

Use check sheets to collect data for the likely major causes.

Arrange the data in descending order of value and calculate % frequency and/or cost and cumulative percent.

Plot the cumulative percent through the top right side of the first bar.

Carefully scrutinise the results. Has the exercise clarified the situation?

In conclusion

Even in circumstances which do not strictly conform to the 80 : 20 rule the
method is an extremely useful way to identify the most critical aspects on
which to concentrate. When used correctly Pareto Analysis is a powerful
and effective tool in continuous improvement and problem solving to separate
the ‘vital few’ from the ‘many other’ causes in terms of cost and/or frequency
of occurrence.

It is the discipline of organising the data that is central to the success
of using Pareto Analysis. Once calculated and displayed graphically, it becomes
a selling tool to the improvement team and management, raising the question
why the team is focusing its energies on certain aspects of the problem.